Economics

There's no such thing as permanent

IF THE incidence of the word recession in news reports is a leading indicator of looming economic downturn, then the frequency with which the word stimulus appears must be a similarly good, if perhaps lagging, sign of slowdown. Now that something resembling an actual stimulus plan is on the table--President Bush's one-time tax rebates--economists have begun shifting their stimulus critiques from the general to the specific. The specific consensus seems to be that one-time rebates, while satisfying the common demands that stimulus be timely and temporary, are not the best idea.

The particulars of the dissatisfaction vary. Megan McArdle, in the most intriguing post I've seen on the subject, highlights research showing that phrasing the one-time payments as "rebates" rather than "bonuses" alters consumer perception of the wealth change enough to blunt the effect of the cash. Other critics continue to point out that in most cases, the heavy stimulatory lifting is done by monetary policy and not fiscal injections.

An increasingly common refrain is that any temporary tax rebate is unlikely to be of much use. Bruce Bartlett, a former Treasury official, made this argument in Saturday's Wall Street Journal. He referred to Milton Friedman's permanent income hypothesis, which suggests that individuals prefer a smooth consumption path. If a tax change is seen as temporary, then consumers will likely save much of the gain (or borrow to cover the loss) from that change to insure against reversion to original rates at a later time. To generate a real change in spending, Mr Bartlett argues, a change in permanent income is required, which therefore means a permanent change in tax rates.

As Mr Bartlett notes, those are not on the table, and a good thing, too, if one believes Mr Friedman's hypothesis. If it is the case that consumers will save a one-time rebate because it is temporary, then we must also assume that consumers are smart enough to see a tax cut in a deficit environment as likewise temporary. Mr Bartlett may say permanent, but rational consumers will ignore him, recognising that the borrowed money must be repaid somehow, in some form, by someone, eventually. As such, some of the "permanent" change in disposable income must be set aside to cover future debt repayment. You can't have your permanent income hypothesis and borrow forever, too.

In the end, the debate about the extent to which consumers will save or spend their windfall seems silly. If we have decided that fiscal stimulus is necessary, then the clear thing to do is provide it in a manner ensuring the money's use. As Paul Krugman (and others) have noted, an ideal way to do this is to return money to the states, to be used on public services which have been curtailed due to the unfortunately pro-cyclical nature of local spending.

Readers' comments

Many American companies are involved in oversea markets. Therefore, any indicator that points to a global downturn could be the harbinger of a recession, such the Baltic Exchange in London which tracks large ocean freight orders. The Baltic is down 30 percent since the beginning of the year. Since economist use it as a metric for determining the health of the global economy, it seems that we could be headed toward a recession, if one accepts the notion that a global downturn will have a cascading affect on the U.S. economy. Tom Donohue, NewsVisual

I'm going to spend 2/3s of my one-time tax rebate on a $.50/hr phone bank in India. Is that going to help? ;-)

But seriously, I "do" my friends taxes and this year I have been "handing out" advice about as fast as the government has been "handing out" farm subsidies, imploring my friends to bear in mind that like when the government pays farmers to "grow" corn in MN, Minnesotan farmers should be grateful and then buy farm land in Iowa. The same goes for singy young adults one year out of college. When the government foots the bill for your 4 year college education and then "gives" you a check for not spending the money you earn, you should think about Coffee farmers in Canada and pay off your loans.

>an ideal way to do this is to return money to the
/>states, to be used on public services which have
/>been curtailed due to the unfortunately
/>pro-cyclical nature of local spending.

1. If the only goal is immediate fiscal stimulus, the ideal method is upping foodstamp payments. Push a button in Washington, and all those debit cards have more money in them, which gets spent pretty much immediately--can't be put in the bank. It's by far the most efficient way to drop money from helicopters. And it provides the greatest bang for the buck: $1.73 in demand for each dollar dropped.

Mankiw dismisses the idea for rather odd reasons, which I won't inflict here. Lengthier comments here: